Canada’s banks are expected to book weaker profits, capping off a fiscal year marked by spiking expenses, rising capital requirements and higher provisions for potentially bad loans.
As the country’s largest lenders prepare to report fourth-quarter earnings this week, analysts cut their expectations – as they did ahead of most of the quarters throughout this year. They anticipate that earnings will drop between 3 per cent and 7 per cent year-over-year, weighed down by mounting costs, rising risks and tepid loan growth.
Keefe, Bruyette & Woods analyst Mike Rizvanovic said he expects a “a noisy quarter to end a challenging year.” Fourth-quarter results may be “very messy, particularly in the expense line, in some cases related to severance charges,” he said in a note to clients.
Many lenders have already started cutting costs. In August, Royal Bank of Canada reported that its number of full-time employees fell 1 per cent from the previous quarter, and that it expects to further decrease its work force by 1 per cent to 2 per cent in the fourth quarter.
In October, Bank of Nova Scotia said it is cutting 3 per cent of its global work force and trimming some real estate holdings.
Some of the banks are also caught in the throes of closing and integrating acquisitions, navigating regulatory scrutiny or launching turnaround plans.
RBC’s pending takeover of Britain-based banking giant HSBC’s Canadian unit has drawn the ire of federal opposition parties, as well as environmental and other stakeholder groups. Bank of Montreal completed its integration of California-based Bank of the West in September and is focused on hitting its revenue and cost targets in the coming years. And Bank of Nova Scotia is preparing to unveil its strategic overhaul plan in December aimed at revamping its operations in Latin America and increasing its domestic business.
Meanwhile, investors are waiting for further details on Toronto-Dominion’s expected fines or other penalties stemming from probes by regulators and law-enforcement agencies, including the United States Department of Justice, related to its anti-money-laundering practices.
The pending announcement may “have actual repercussions for TD medium term,” including non-monetary penalties such as cease-and-desist orders, RBC analyst Darko Mihelic said in a note to clients.
CIBC analyst Paul Holden said he expects a penalty of about US$500-million. “Our base case estimates suggest limited downside, but something worse than base is possible and that is what introduces potential risk heading into” the fourth quarter, he said in a note. Scotiabank analyst Meny Grauman said TD could set aside $1-billion for legal provisions in anticipation of a coming fine.
On Tuesday, Bank of Nova Scotia is the first major bank to report earnings for the three months ended Oct. 31. Royal Bank of Canada, Toronto-Dominion Bank and Canadian Imperial Bank of Commerce will release results on Thursday. Bank of Montreal and National Bank of Canada will close out the week on Friday.
Canadian stocks have languished this year as high inflation and dampening demand for lending weighed on earnings. The S&P/TSX Composite Banks Index slumped 6.2 per cent year-to-date, underperforming the benchmark index’s 3.7-per-cent rise.
The cost of borrowing has risen as interest rates climb, boosting the risk that clients could default on their loans. The banks have been setting aside more money for loans that could turn sour – known as provisions for credit losses.
While provisions are climbing, the banks are rebuilding their reserves from historically low levels in 2021. At the onset of the COVID-19 pandemic in 2020, banks set aside more provisions to hedge against an expected wave of defaults that never materialized.
Most of the provisions set aside this year were allocated to loans that were still being repaid but at risk of defaulting. But analysts say banks will reserve more money for debt that is not being paid on time as default levels recover from their pandemic lows.
The lenders are also facing a stricter regulatory environment as Canada’s banking watchdog increased capital requirements. On Nov. 1, the Office of the Superintendent of Financial Institutions (OSFI) increased the domestic stability buffer (DSB) – a capital reserve banks must build as a cushion against an economic downturn – forcing the largest lenders to set aside billions of dollars.
OSFI plans to announce its next decision on Dec. 8, with some investors and analysts split on whether the regulator will announce another increase.
The increase also prompted a change to the minimum capital levels a bank must hold. The common equity tier 1 (CET1) ratio – a measure of a lender’s ability to absorb losses – climbed to 11.5 per cent. Each of the big banks are expected to post a CET1 ratio of more than 12 per cent in the fourth quarter.
A “deteriorating macro backdrop supports no increase,” Bank of America analyst Ebrahim Poonawala said in a note. But “most investors expect OSFI to raise the DSB given the desire to shore up capital levels, ahead of a potential downturn. We believe banks are well-positioned to absorb the DSB increase.”